Public Bill Committee

[Mr. Roger Gale in the Chair]

Clause 4

Special resolution objectives

Amendment moved [this day]: No. 77, in clause 4, page 3, line 19, at end insert
; and for the avoidance of doubt, this includes ensuring
(i) continuity of service; and
(ii) unrestricted access to deposits..[Mr. Hoban.]

Roger Gale: I remind the Committee that with this we are discussing the following: Amendment No. 74, in clause 4, page 3, line 19, at end insert
(6A) Objective 3A is to protect and safeguard the value of the enterprise..
Amendment No. 78, in clause 4, page 3, line 20, at end insert
and to ensure that the expenditure of any public or private funds is done in an economically efficient manner..
Amendment No. 76, in clause 4, page 3, line 22, at end insert
(8A) Objective 6 is to protect the interest of creditors.
(8B) Objective 7 is to avoid distorting competition amongst banks..
Amendment No. 79, in clause 4, page 3, line 24, at end add
(10) In respect of Objective 7, competition law shall apply to a bank, whether it is wholly or partly owned or controlled by the Government, including a bank to which sections 9 and 12 apply.
(11) Where a bank is wholly or partly owned or controlled by the Government and where section 214 applies, the bank is prohibited from using its favourable position or Government support to its commercial advantage and thereby to prevent, restrict or distort competition in the market for financial services as a whole, or on a product by product basis.
(12) For the purposes of subsection (10) competition law includes the provisions of the Competition Act 1998 and the Enterprise Act 2002, and European Community law competition provisions.
(13) For the purposes of subsections (10) and (11) ownership or control shall be determined by reference to sections 26 and 29 of the Enterprise Act 2002 and by reference, where Community law applies, to the Council Regulation 130/2004 (the European Merger Regulations)..
Clause stand part.

Mark Hoban: Welcome to the 10th sitting, Mr. Gale. I had just taken an intervention from the hon. Member for South-East Cornwall before we adjourned; we were discussing my proposal to include a competition objective in the Bill, so that the issue is recognised and used when determining how the toolsthe stabilisation powers, the bank insolvency procedure and the bank administration procedureare used. We must think about the powers, not only in the context of the five objectives, but also the potential further objective of avoiding the competitive impact that a bank subject to those powers could have.
The hon. Member for South-East Cornwall alluded to the possible tension between a competition objective and a banks ability to repay taxpayers funds quickly. We talked about that in the context of Northern Rock earlier. Restricting the ability of a bank that is subject to one of the powers to compete could delay the repayment of any financial assistance that that bank had received from the taxpayer, because it would not be in a position to attract new funds from retail depositors, for example. Conversely, if the restriction was on offering mortgages and lending, that might hasten its ability to repay taxpayers money, depending on the dynamic and the particular competitive effect that we want to deal with. As we discussed before lunch, there are tensions within the objectives in the Bill and within some of the proposed objectives, but it is important to understand the role that the objectives will have and how they will shape decisions that the tripartite authorities will make about the stabilisation powers.
Two points emerge from the code in relation to the objectives. Paragraph 17 of the draft code states:
Following actions taken under the SRR, the Authorities must make public statements explaining (a) how they have acted with regard to the SRR objectives; and (b) how they have balanced the objectives against each other
which refers to the tension that we have been debating.
The form such an explanation will take will depend on the circumstances.
Can the Minister say how long we shall have to wait for such a statement after the powers have been used? Will it accompany the exercise of the powers or will it appear a couple of months later, after the powers have been exercised? Obviously there is an issue about timing and the nature of the information that can be disclosed by such an explanation. Paragraph 18 of the code points that out:
It should be noted that it will not be possible to divulge certain information, for example information the release of which would threaten financial stability or the confidence of the banking system.
Clearly the longer that is left, the more information could be received, but it will also mean that market participants will be in the dark about why the authorities have taken the steps that they have. The sooner the information is released the more difficult it is to give a full explanation. Does the Minister see that tension being resolved?
Does the Minister feel that the Treasury statements released in the aftermath of the FSAs triggering the threshold conditions for Kaupthing and Heritable constitute a template for what we should expect under clause 17? I hope that the answer is no, because the statements did not clearly explain why the Government were taking those actions. I shall return to that point in a little more detail on clause 7, which deals with the threshold conditions.
Secondly, I want to understand the interaction between the objectives of the FSA under clause 4 and the Financial Services and Markets Act 2000. The subject is raised in the code. Paragraph 16 states:
The sole exception to this rule relates to a decision taken by the FSA, under section 7 of the [Act] that the general conditions for use of the SRR have been met. This decision will be taken in the context of FSAs objectives under the Financial Services and Markets Act 2000.
I appreciate that we could cover the subject in more detail when debating clause 7, but there seems to be a carve-out later in the Bill saying that the objectives in clause 4 will not be applied to the exercise of the powers under clause 7. It would be helpful if the Minister were to elaborate on the interaction between the objectives of clause 4 and the 2000 Act, and specifically why they are carved out in clause 7.
One of the challenges in trying to understand the objectives and their application is the lack of transparency in the Bill, the explanatory notes and the code on how they will interact, and on how they will return the powers that could be used under parts 1, 2 and 3 of the code. The code is meant to be a safeguard on the exercise of power. I would have expected it to say rather more about the interaction of objectives.
The amendments are probing; we seek to understand the scope of the objectives, how they work together and how they relate to other aspects of the Bill, including references to the protection of creditors and compensation that are not reflected in clause 4. I want to know how those objectives will work, why they are limited to five and why they do not include competition and the protection of creditors and shareholders. We would be comfortable if the Minister were to give a fairly full explanation on those points. We look forward to his doing so.

Colin Breed: I wish to speak to amendment No. 74, which is in my name and that of my hon. Friend the Member for Southport. As I said this morning, it is complementary to the other amendments to this important clause. However, it is particular in adding to the third objective, that of protecting depositors. As the hon. Member for Fareham said, it should cover depositors in the widest sense; I assume that it means retail depositors, but it may include others.
The amendment would add the words
to protect and safeguard the value of the enterprise.
That is important when we come to the use of the special resolution and the stabilisation powers, which are set out in clause 4(2)(a) rather than in banking insolvency or administration procedures. At that stage, the bank may well be tradingindeed, it is likely to be tradingand will not necessarily be a failed bank. It might become a failed bank, but at that moment it will not be failed in the legal sense. Paragraph 9 of the draft code of practice reads:
The term protection of depositors refers specifically to the objective of protecting depositors from the effects of the failure of an institution.
The actual moment of failure is an important aspect. When a bank has failedperhaps gone into insolvency or administrationthat is one thing, but before that, it is considered whether the bank is going to be a failure. Paragraph 9, about which I have some other comments to make, mentions
the effects of the failure of an institution, as an end in itself.
What concerns me is that it is likely, as we found out in Treasury Committee meetings on Northern Rock, that the FSA was aware of some of the problems with Northern Rock some months before it failed. Although the bank was considered in many respects to be an outlier in how it secured wholesale funds and so on, it was given time to try to put it right. The fact that it did not do so, or that the FSA did not insist that it do so, is another matter, but during that period the bank was not failed. It was trading, receiving deposits and entering into mortgage arrangements, and although it was perhaps on the list for close attention, at that moment in time it had not failed.

Mark Todd: I think that the evidence of the internal audit was that it was not on any list for close attention. That was one of the major problems with Northern Rock: it was attended to all too little.

Colin Breed: It may have been attended to all too little, but the FSA had it on close watch from January. The report says quite clearly that it had been brought to the attention of the directors. It had been perceived as an outlier in terms of its chart and what it had done, and it was working with the FSA. Nevertheless, it does not matter whether it happened in January or in March. It was quite some time before the events of August, when it actually failed. Northern Rock was in intensive care, which may be the sort of situation in which we find ourselves if the special resolution regime is imposed in future. Banking organisations might begin to display all the potential signals that they are heading towards the rocks, but at that moment, they might not be.
It should be necessary to ensure that the overall value of the entity, which is often in large part goodwill rather than just tangible assets, is maximised for everyone during that period. Of course, once it goes into administration or insolvency, there are clear rules about how the administrator may act, but until that happens and while it is still under the stabilisation powers, it is important that consideration be given to maximising the value of the bank in its fullness. That is consistent with directors duties to promote the success of a company under section 172 of the Companies Act 2006. During the period of intensive care that may precede the failure of the bank, it is important that that principle is maintained. That is the purpose of the amendment.
I readily accept that this is a subjective judgment on timing, and timing is all important in such matters. While things can go on for quite a few weeks, matters often come to a head quickly and something happens. We may therefore go from an attempted stabilisation to a wholesale failure. It is important, however, that when we think about protecting the depositors, which I know is the main thrust of the legislation, we do not lose sight of other aspects of the bank. We know, for instance, that large pension funds are normally significant investors in banks.

Peter Bone: The hon. Gentleman is making a good point. I wonder whether he has a view on the following. I understand from these objectives that the Government are not talking about the normal business relationship and the normal duty of directors to look after the whole of the company, but are saying that they will look after a specific group of creditors, that is, the depositors. Does the hon. Gentleman agree that that looks as though the Government are sinking?

Colin Breed: That certainly may be the impression. As I said, the main thrust of the legislation is to protect depositors. We should not lose sight of the fact that prior to actual failurewhen there are clear rules for the way in which administrators may undertake their duties, and the relative classes of shareholders, creditors and so on are more easily establishedif one still has a going concern, although it may be limping along, it is important to recognise that directors have other duties. There may well be an opportunity to rescue the situation before it goes into failure, and to have regard for maximisation. Once intervention happens, share prices can disappear and the value of the entity can evaporate overnight. It is important that we do not lose sight of the objective that while there is still a going concern, the creditors and shareholders should have at least some say in what is going on.
It would be helpful if the Minister gave us some basic assurances that in the period when stabilisation powers are being introduced and we do not have an actual failure, the Government have a view as to how that is to be handled. At the end of the day, it must be normally in everybodys interest to try to save the institution and ensure in one way or another that it continues. To have a further contraction, through a merger or a takeover, is not likely to be in the interests of competition. To have a failing bank is not likely to be in the public interest or the economic interest; it is not likely to be in too many peoples interest. It is therefore important that in that period these powers are used, as much to try to ensure the continuation or the maximisation of the value of the whole, as to try to get to a situation where the company is split up, sent off, recast and such, and we have shareholders taking a real bath, creditors losing out, and everything else.
I would be grateful to the Minister if he addressed that period when a company is not insolvent, but is in intensive care, when the directors are doing all sorts of things to try to maintain their business, and if he said something about how these powers will be used in those circumstances.

Peter Viggers: Mr. Gale, rising gives me the opportunity to apologise to you and to the Committee for my mobile phone going off. I thought that I understood the technology; I clearly do not.
My first point is not the most serious one I have ever made in Committee. Under clause 1(5), each of three bodies has a role in the operation of the special resolution regime, and they are listed as the Bank of England, the Treasury and the Financial Services Authority, whereas when we reach clause 4(3), the same three bodies are listed in a different order: the Treasury, the FSA and the Bank of England. The parliamentary draftsman never does anything for no purpose, and I would be curious to know the purpose of that particular difference in listing. The listing accepted in the rest of the Bill is the same as that in clause 4(3), so it must be clause 1(5) that is out of order. That is not my biggest point.
The more important points are that the Bill is predicated on supporting depositors, as the hon. Gentleman has just mentioned. Clause 2(1) talks about accepting deposits. Accepting deposits and the protection of depositors seem to be a prime purpose of the Bill, but there are other bodies and other ways that banking institutions can interface with public confidence.
Increasing confidence is not just a matter of protecting depositors. There have been some quite serious mismatches, which have caused the public and our constituents real concern. For instance, there was a mismatch between the treatment of individual depositors in the Icelandic associate banks in the Isle of Man, such as Kaupthing Singer & Friedlander, where individual depositors are not protected. Similarly there is a mismatch between the individuals who invested money by way of deposits through Icelandic banks and the institutions that invested money through Icelandic banks, such as councils and, as I mentioned earlier, a childrens hospice in my constituency.
There are other ways that banks can interface. If we wish to protect confidence, it is not just a matter of ensuring that deposits are fair. For instance, if a bank were involved in, for example, bills of lading, and the bills of lading failed, that would cause a loss of confidence. It would not just be a matter of losing deposits. A breakdown in money transmission would have a significant impact on confidence. A fault in the custodian system, whereby pension funds are held by banks, would cause a problem. If a bank failed in its capacity as either a trustee or a factor of money, that would cause a problem.
We have already noticed that investment banks are not covered by the rules on the protection of depositors. What would happen to investors in banks where there is no deposit because the interest is payable under sharia law and is a shared venture? What is the rule there? My questions come down to this. Which depositors are protected? Is it UK individuals only or is it every UK institution, as there has been a mismatch so far? Secondly, depositors in what? Is it just depositors in UK banks or depositors in UK institutions as well, or depositors in overseas institutions, including banks?
My question can be summed up as follows: if the object of the exercise is to protect confidence by ensuring that depositors are protected, then a more careful definition of exactly what institutions will carry this cover is needed. What institutions have the reputation that if a deposit through them is lost, the UK Government will stand behind them through the special scheme?
There is insufficient clarity here. Lawyers acting for banks and other financial institutions will be all over this Bill when it is an Act. They will look for the interstices in it and clever ways of getting protection, which we perhaps have not anticipated. I would be a little happierwe may come to this when we consider the draft code of practiceif the law had been cast in more general terms and enabled the Bank of England to do such things as may be necessary to protect deposit and other customers of banks. But that is perhaps for a later discussion.

Ian Pearson: Lawyers have already been over the Bill. They continue to go over it in substantial detail. The amendments seek to add to the objectives for the special resolution regime set out in clause 4. Before dealing with them in turn, I should like to set out the thinking behind the objectives we have put forward in the Bill and explain why I think they are the right ones.
The clause sets out the special resolution objectives, which are intended to present in primary legislation the broad purpose of the measures we have put in place and the aims that the authorities must have regard to when exercising their powers under parts 1, 2 and 3. I hope that the hon. Member for Gosport welcomes the fact that we are doing this at a broad level.
We have consulted widely on these objectives and they have received strong support. While the objectives are not defined in the Bill, the code of practice, which the hon. Member for Fareham referred to and which was sent to members of the Committee on Thursday, provides further information on their meaning and effect.
I will help the Committee by summarising what the draft code says as to the meaning of these objectives, as this touches on some of the points that hon. Members have already made in the debate; they are also covered in the amendments. Members will, I hope, forgive me if much of the following quotes extensively from the code, but it is important that these definitions are made clear before the Committee today, in order to inform debate.
The term
stability of the financial systems of the United Kingdom,
used in objective 1, refers to the stable functioning of the systems and institutionsincluding payment and settlement infrastructuresupporting the efficient operation of financial services and markets for purposes including capital raising, risk transfer and the facilitation of domestic and international commerce. As the Committee discussed last Thursday, there are a number of possible definitions of what stability does, or could, mean in different contexts; this definition provides a clear explanation in terms of the stability of the UK financial systems.
The intention of this initial objective is first, to recognise the wider systemic risks posed by the potential, or actual, failure of any institution or group of institutions. Secondly, it requires the authorities to have regard to the likely systemic impacts of their actions, or non-actions, when implementing an SRR tool.

Mark Hoban: The Minister referred, as I did, to last Thursdays debate about financial stability. Does he not agree with me that the definition set out on financial stability in the code is likely to be the one by which people will judge the achievement of the effectiveness of clause 216? Will this in effect become the definition of financial stability? Should that not be recognised in clause 216, as well as in the code?

Ian Pearson: For the reasons that I outlined last Thursday, it is right that we do not put a detailed definition of financial stability in the Bill. We believe that the right place to do that is in the code, which is why we provided that clarification in terms of our understanding of objective 1.
Objective 2, and the term
public confidence in the stability of the banking systems,
refers to the crucial role that public confidence has in maintaining the stable and efficient operation of financial services and markets. The confidence of the general public is of particular significance in maintaining stability in a banking system whereby it is important that banks deposit liabilities exceed the liquid assets that they hold at any one time.
Public confidence has a number of dimensions. For example, it refers to the expectation that deposits will be repaid on demand; normal banking services will be continuously available; problemsor perceived problems in one bank or building society will not extend to other banks; and if a bank or building society does fail, systems exist to protect the interests of depositors.
The intention of the second objective is to ensure that the authorities have regard to the need to act so that a failing bank or building society will be resolved in a manner that enhances public confidence in the banking system as a whole.
The term protect depositors in objective 3 refers specifically to the objective of protecting depositors from the effects of the failure of an institution, as an end in itself. That objective goes beyond the need to ensure public confidence in the banking system, and recognises the important public policy objective of ensuring that depositors in a failed institution are adequately protected.
Under the Bill, such protection can be delivered in different ways, such as by facilitating fast payout, or account transfer, under the Financial Services Compensation Scheme to eligible depositors through the bank insolvency procedure, or facilitating continuity of banking services through the stabilisation options in the SRR.
Public policy concerns around effective depositor protection are particularly relevant in the case of retail depositors protected by the Financial Services Compensation Scheme. Protection of retail depositors is also likely to be conducive to realisation of a number of other objectives, such as protecting and enhancing public confidence in the banking system. However, the use of the SRR may also offer protection to other types of depositor, particularly where the SRR tool chosen may provide continuity of service to both retail and non-retail customers of a failing institution.

Mark Hoban: May I pick up the comment made by my hon. Friend the Member for Gosport? I want to check that the Minister is rightor that what I take from what he says is rightthat depositors as a term expands beyond retail depositors, to cover all depositors. Clearly, if the decision were taken to put a bank into administration, retail depositors would be covered by the FSCS but non-retail depositors would rank alongside other creditors in terms of distribution. They might argue that the choice of mechanism made by the authorities did not protect them while it did protect retail depositors. I wonder whether the use of the word depositor is not too widely drawn.

Ian Pearson: The objective to protect depositors covers all depositors, retail and wholesale, but I would point out that the focus of the SRR will often be primarily on retail depositors eligible for compensation from the FSCS, as demonstrated by the bank insolvency procedure which is designed to speed up payout to this class of creditors. It is right that the objective covers both retail and wholesale depositors.
The term protection of public funds in objective 4 refers primarily to the protection of taxpayers interests in the effect of expenditure of public money. The intention of this fourth objective is to recognise the strong fiduciary duty of the authorities, in particular the Treasury, in taking decisions with implications for public funds.
The term in objective 5,
to avoid interfering with property rights in contravention of a Convention right
refers to the rights of property holders who might be affected by the use of the SRR. This can include the bank or building society itself, the shareholders, creditors or other third parties. Such persons may hold property in the failing bank or building society or have a right of control over such property, or both. The inclusion of this objective acknowledges the importance of acting proportionately in exercising these powers.
The hon. Member for Fareham asked in the early part of his contribution about the definition of proportionality in the code. This is an issue that has been considered repeatedly both in domestic and international case law. In broad terms, it means that property rights should be interfered with to the minimum extent necessary to achieve the public interest aims, albeit those aims may provide very powerful justifications for intervention.
This clause also notes that the objectives are to be balanced as appropriate in each case. Again, the hon. Member for Fareham invited me to speculate whether particular areas have priority. I want to make it clear that we need to look at these on a case-by-case basis. We have always been clear that our primary objectives are to protect depositors and financial stability, and stakeholders have supported these purposes. We have included other rights, such as protecting property rights, in acknowledgment of the potentially invasive nature of some of these tools. It is right that we judge our action on a case-by-case basis.

Peter Bone: The Minister has been most helpful but is it not unfortunate that the Bill does not say that the primary purpose is those two objectives? The Minister has said it but the Bill does not say it.

Ian Pearson: We have been clear that depositor protection and public confidence in the banking system are essential. When deciding to take action, it is right that the special resolution objectives should be as we have set out in clause 4. I refer hon. Members again to subsection (9), which says that
they are to be balanced as appropriate in each case.

Peter Bone: Will the Minister give way?

Ian Pearson: Prolonging the discussion will not particularly help in this case.

Peter Bone: It would help me.

Ian Pearson: We think that these are the right objectives. What is important is that we have the flexibility to look at the appropriate balance of such objectives on a case-by-case basis.

Peter Bone: Will the Minister give way?

Ian Pearson: Oh, go on then.

Peter Bone: I am grateful for the gracious way in which the Minister gave way. Will he go away and think about the matter? Clearly, he is correct in what he says. However, that is not what the clause says. We cannot have all the objectives jumbled together; we have to have some primary ones. The Minister is right to say that the two primary objectives are financial stability and depositor protection, and that is all that needs to be said in the clause. I know that the wording will not be changed now, but perhaps the Government can go away and reflect on it.

Ian Pearson: I do not want to go away and reflect on it, actually, because we considered the measure at some length before coming to the conclusion that these are the right objectives. Together the objectives capture the public interest that should be pursued in operating the special resolution regime, and are the most important factors to which the authorities should have regard when taking action under the SRR. That is why we believe that including the objectives in the Bill provides guidance to market participants and other stakeholders as to how the SRR powers will be used.
We believe that it is impossible to define the objectives exhaustively. The concepts at issue are too complex to be reduced to hard-edged statutory definitions. The applications of the objectives may well change over time. That is why we have the code of practice, to elaborate in more detail how the objectives are to be interpreted and applied. That was the point that I made to the hon. Member for Fareham earlier.
Let me now turn to the amendments that have been proposed on the objectives. I hope to reassure the Committee that the issues that have been raised are already appropriately dealt with in the Bill as it stands. I want to make it clear why I do not believe that we should amend clause 4 in the manner that has been proposed.
In discussion of the detailed definition of the SRR objectives as set out in the code of practice, let me explain why I believe that both the second and third objectives, as set out in the Bill, implicitly include the concepts of access to deposits and ensuring continuity of banking services. If there is any doubt regarding that, the code of practice, to which the authorities must also have regard, makes it explicitly clear. I do not believe that amendment No. 77 is necessary.
Amendment No. 74, tabled by the hon. Members for South-East Cornwall and for Southport, calls for a requirement
to protect and safeguard the value of the enterprise.
I presume that means the enterprise value of the failing bank. The enterprise value of a company is usually made up of a number of elements, including the market capitalisation of the bank. That is the market value of all its shares in issue in addition to the value of its debt financing and other liabilities. I do not believe that a core objective of the SRR should be to protect this measure of the value of a firm. When a failing bank enters the SRR, the stabilisation options in the Bill are deployed because the authorities believe that they are necessary in the public interest. At this point, it is the Governments view that the wider public interests of financial stability, depositors interests and protection of public funds may well outweigh the commercial interests of the bank.
I want to reassure the hon. Member for South-East Cornwall that a number of specific features of the SRR will operate to safeguard and protect the value of the failing bank. The Bill is designed so that the stabilisation options of a transfer to a private sector purchaser, such as a transfer to a bridge bank or taking the bank into temporary public ownership, can be applied before the insolvency threshold has been reached. In turn, that helps to protect against the destruction of any residual value that the failing bank has upon entering insolvency. I think that that addresses the hon. Gentlemans point.
I should also like to draw the attention of the hon. Member for South-East Cornwall to clause 53, which introduces the bank resolution fund. The fund, which is compulsory for a bridge bank but optional when taking a bank into temporary public ownership, is designed to ensure that the proceeds of any resolution, minus deductions necessary adequately to safeguard public funds, must flow back to the failing bank. If the Bank of England or the Treasury put in place a bank resolution fund, the resolution fund order may place a duty on the authorities to maximise the proceeds available for distribution, subject to meeting the special resolution and bridge bank governance objectives. I believe that that mechanism should also help to achieve the result that the hon. Gentleman is looking for. I therefore hope that he does not press the amendment to a Division.
Amendment No. 78, tabled by the hon. Member for Fareham, proposes that we state that the expenditure of public and private funds is done in an economically efficient manner. Of course I agree with the intention of the amendment, but again, I am not convinced of the argument to make it an objective of the special resolution regime. First, there are adequate general mechanisms to monitor and provide oversight of the use of public and private funds by the Government and other public bodies. In addition to the value-for-money and propriety analysis that the Government will undertake before providing financial assistance, there are external mechanisms to ensure that assistance is provided in an appropriate manner, for example through the work of the National Audit Office.
If the hon. Gentleman is referring to funds of the FSCS when he mentions private funds, I should say that we have put in place a number of provisions to ensure that they are used in an appropriate manner, when called on to fund the SRR, as in clause 157. I refer him in particular to the requirement that any resolution costs that the FSCS must contribute should be independently verified, and the core principle that the FSCS cannot contribute more than it would have had to pay out to insure the depositors had the bank entered insolvency.
I also do not agree that the objectives that the hon. Gentleman proposes in amendment No. 76 should be included in the Bill. The amendment proposes that the protection of creditors should be a separate SRR objective. Let me set out why I do not believe that that part of the amendment is necessary. First, as I have said, objective 5 operates to ensure that any interference with the rights of creditors must be in the public interest and proportionate. Secondly, there are in addition a number of specific features of the SRR that operate to protect non-depositor creditors, such as the protection of set-off and netting arrangements in the case of a partial transfer, which we will discuss in due course when we come to clause 43. Furthermore, I draw hon. Members attention to the compensation provisions that we have provided, particularly the possibility of compensation being payable to creditors under a third party compensation order. In relation to partial transfers, there is the additional safeguard, reflected in clause 55, of ensuring that no creditor would be worse off than in a whole-bank insolvency.
We can certainly agree that the interests of creditors need to be taken into account when determining whether the SRR should be deployed and that their interests need to be respected, but we do not think that it is appropriate to provide expressly for the protection of creditors as a separate objective from the protection of depositors. Creditors, to a much greater extent than retail depositors, can take a number of steps to protect themselves in the event of counterparty failure, including taking security and adopting set-off and netting arrangements. When creditors stand unsecured, they do so in the knowledge that that is the case, and having secured a suitable rate of return on the terms of their liability with the bank. None of that is the case with depositors. The Government have made it clear that the class of creditor that the measures focus on protecting is the depositor class, both as an end in itself, and because of the important role of depositor protection in financial stability.
Finally, I should like to turn to the important topic of competition law. I believe that the intention behind amendments Nos. 76 and 79, tabled by the hon. Member for Fareham, is to ensure that a bridge bank or a bank in temporary public ownership does not take commercial advantage of its favourable position in terms of Government support in a manner that distorts the market for financial services as a whole. He made that point clearly in his contribution.
Again, I reassure the hon. Gentleman that we have put measures in place to meet that intention. The first is the code of practice, the draft of which includes measures regarding the running of a bridge bank or a bank in temporary public ownership and guidance on running the bank on a conservative basis. Furthermore, both bridge banks and banks in temporary public ownership will continue to be regulated by the FSA in the same manner as other financial services providers. The Office of Fair Trading will continue to keep the relevant markets under review in order to protect the interests of UK consumers and the British economy. As the amendment addresses the running of bridge banks and banks in temporary public ownership rather than the general operation of the special resolution regime, I argue that the measures that I have set out meet his aim more appropriately.
The hon. Gentleman also probed the extent to which banks in receipt of financial assistance will be permitted to take advantage of that assistance in an anti-competitive manner. That is an important point. It is crucial that banks cannot use the receipt of financial assistance to obtain an inappropriate competitive advantage. I reassure him that firms in receipt of financial assistance will still be subject to the provisions of competition law and that the competition authorities will continue to have the powers to investigate any breaches. As I have said, the Office of Fair Trading will continue to keep the relevant markets under review in order to protect the interests of UK consumers and the British economy. Additional restrictions may also be imposed on those in receipt of financial assistance in order to comply with the rules on the provision of state aid.
Returning to the point about priorities, the hon. Member for Fareham made the Governments argument for us when he pointed out that the weighting of the different objectives outlined in clause 4 may change in different times and contexts. He is absolutely right. It illustrates why we should not attempt to rank objectives in the Bill, despite the injunctions of some Opposition Members. To give one example, in cases where significant public financial assistance had been committed before the special resolution regime, objective 4 on the protection of public funds would be likely to increase in importance, but it is not possible or desirable to put into the Bill the sorts of trade-off that the hon. Member for Fareham discussed or to stipulate in advance what they might be.
The hon. Member for South-East Cornwall sought assurance that the aim is to preserve a viable entity. I confirm that that is exactly the case. Before the SRR operates, the objectives of the banks management and the FSA as its regulator will clearly be to run it as a going concern. Once the bank is in the SRR, subject to the objectives that we are debating, the authorities aim will be to preserve the business or part of it as a viable business entity. All along, pre-SRR, we want businesses to continue as going concerns. Once a business is in the SRR, the first point is to preserve all or some of its parts as viable business entities.
I hope that I have demonstrated that the SRR objectives in the Bill strike the right balance between being clear about our primary aims and the purpose of the SRR measures and protecting other important rights and interests. I also hope that my explanation of other measures in the Bill and the code of practice address the concerns raised in the amendments. I hope that that provides adequate reassurance that we have taken those important matters seriously, that hon. Members, who I think tabled the amendments in a probing spirit, will not press them and that we can agree that clause 4 should stand part of the Bill.

Mark Hoban: I thank the Minister for his full reply to our debate on clause 4. Given his remarks, I want to reflect on a few points. We had an exchange during his speech about what was meant by depositor. I am still concerned that the Bill deals with depositors in a rather broad way. The explanatory notes do not clarify the position, so we are reliant on a non-binding code of practice for a clearer definition.
I do not want a local authority or charity depositor to look at the objectives and say that the Government had not protected them because they had been ranked alongside the window cleaner and the person who provides the stationery when it comes to the payout on administration for insolvency. I believe that we need greater clarity about the different levels of protection given to the different types of depositors in the various sectors. A retail depositor has a very different set of protections from a non-retail depositor. That does not come across, either in the Bill or in the explanatory notes, and it is not as clear as it could be in the code of practice. It is important to make it absolutely clear to depositors what protection they are likely to receive under the scheme.
There is a gap that the Government need to consider on the question of financial stability. The working definition used in the evidence session at the start of the process by the Banks executive director for financial stability, Nigel Jenkinson, was narrower than the definition in the code of practice. We could end up with the Bank believing that it was accountable for one thing in the context of how it operates, with the code of practice expressing financial stability in a wider fashion. The two should be more closely aligned, so that all the tripartite authorities know exactly what is meant by financial stability.
It was conceded on Thursday that this business should be covered by the Bill, but the Bank and the Treasury should be singing from the same hymn sheet. I am not sure that they are. That will add to the confusion over the respective roles of the Bank and other tripartite authorities and how financial stability is to be addressed under the Bill, particularly under part 1. More work needs to be done on that aspect.
The balance of objectives is dealt with in subsection (9); my hon. Friend the Member for Wellingborough debated it with the Minister, and I touched upon it in my remarks. One part of the challenge is that people will need to know how the objectives work together in different circumstances. One objective of the codewe will talk about it in our debates on clause 5is to give some clarity and predictability. Clause 5(2)(a) is about how to achieve the special resolution objectives. We need a window in the code on how they interact at different times. I agree that they may vary; indeed, the code reflects on the fact that they may vary, depending on the time.
I drafted amendment No. 77 before I saw the draft code. Paragraph 10 of the code makes much clearer how depositors might be protected. Amendments Nos. 74 and 76 are on the value of the enterprise and the interests of the creditors respectively. I am not sure whether the safeguards identified by the Minister are sufficient to reassure creditors. The safeguards come across almost as a second-order priority, because they are to be dealt with in secondary legislation or in a different clause. The fact that they are not in clause 4 indicates that creditors rights are not as important, and the Governments thinking on ensuring that value is left in the business for creditors does not seem as important as some of the other objectives in clause 4. I am not sure whether the Minister has addressed that point fully, and we might want to return to it later.
The Minister teased apart the issue of whether we are dealing with public or private money. I want to touch on the efficient use of private money, which we will probably deal with in more detail under clause 157 about the funding of the regime. There is a provision in the Bill to verify how the money is spentlike an audit. From my accountancy training, I know that an audit does not necessarily show that money has been spent well or efficiently.
Mr. Boneindicated assent.

Mark Hoban: I expect my hon. Friend was both a client and an auditor at different stages of his career before he came to the House. An audit does not provide exactly the reassurance I seek in amendment No. 78. I accept the point about public moneythat the NAO is there to provide an external check, and that before spending taxpayers money the Treasury will go through its own processes to determine whether that is the best way to resolve the crisis; however, the provision for independent verification of the use of the funds that the banking sector will provide to the FSCS, to meet some of the costs of resolution, does not necessarily go far enough.
On competition, I think that the Minister set out to reassure us that there are sufficient checks on an institution that has been subject to one of the stabilisation tools, to ensure that it does not act anti-competitively. During the debate on the code, I might touch on the meaning of conservative in the section dealing with temporary public ownership. The Minister has acknowledged the importance of ensuring that the right arrangements are in place so that banks in receipt of public financial assistance are not unfairly advantaged. It would be wrong to advantage banks that are seen to have failed, to the detriment of those that seem to manage their businesses successfully without recourse to public funds. On that basis, and with the reservation about creditors, I beg to ask leave to withdraw the amendment. I will not seek permission later to press any of the other amendments in the group to a vote.

Amendment, by leave, withdrawn.

Clause 4 ordered to stand part of the Bill.

Clause 5

Code of practice

Mark Hoban: I beg to move amendment No. 81, in clause 5, page 3, line 35, at end insert
(ca) how to determine whether the threshold conditions under section 41(1) of the Financial Services and Markets Act 2000 will be breached,.

Roger Gale: With this it will be convenient to discuss the following: Government amendment No. 89.
Amendment No. 80, in clause 5, page 4, line 3, leave out have regard to the code and insert
comply with the code or publish an explanation of why they were unable to comply with the code in good time after their actions,.
Clause 5 stand part.
Amendment No. 82, in clause 6, page 4, line 11, leave out and.
Amendment No. 83, in clause 6, page 4, line 14, at end insert , and
(d) those persons whom it considers to have relevant knowledge of those matters..
Amendment No. 85, in clause 6, page 4, line 17, at end insert
only after complying with the requirements set out in subsection (1)..
Amendment No. 84, in clause 6, page 4, line 18, at end add
(5) The code shall not come into force unless it has been approved by a resolution of each House of Parliament..
Clause 6 stand part.

Mark Hoban: The code of practice in clause 5, which we have already referred to quite a bit today, is seen by third parties as an important part of the legislation, because it is one of the tools that would give the market comfort regarding how the powers in parts 1, 2 and 3 will be exercised. It is therefore important that the code gets it right and that there is sufficient guidance in it to enable people to predict reasonably well when and how the powers will be used. Subsection (2) of clause 5 sets out some of the guidance that will be included in the code. I will start by talking about my amendments, and then speak more generally about clauses 5 and 6 stand part.
My amendments aim to highlight some of the potential deficiencies in the code as currently drafted. Amendment No. 81 inserts some additional guidance on the context. It reads,
how to determine whether the threshold conditions under section 41(1) of the Financial Services and Markets Act 2000 will be breached.
The code, to be fair, refers to that. Paragraph 28 states:
The FSAs Handbook contains rules and guidance relevant to an authorised firm. In particular, within the FSA Handbook, the COND Threshold Conditions contains rules and guidance on the threshold conditions. There are a range of conditions, including: legal status and location of offices; the adequacy of the firms resources (financial and non financial) in relation to the regulated activities which the firm carries on; and suitability issues (e.g. competent and prudent management, conducting business with integrity and in compliance with proper standards). These are set out in more detail in the FSA Handbook.
I am not sure whether the code really provides the guidance that people need to determine whether the threshold conditions will be breached, or which threshold conditions in particular the Government are interested in. For example, one of the threshold conditions not referred to in paragraph 28 is the appointment of a claims representative. I do not know whether the breach of the appointment of a claims representative will trigger the special resolution regime. I hope it does not, but part of the problem is that we are left none the wiser in the code as to whether that is the case.
On the matter of the location of offices, I printed off the relevant section of the conditions handbook to see whether it might provide me with some more detail. It states that
if the person concerned is a body corporate constituted under the law of any part of the United Kingdom...its head office, and...if it has a registered office, that office, must be in the United Kingdom.
Would the fact that a FSA-regulated firm decides to change its head office and move out of the UK be sufficient to trigger the special resolution regime? It may be sufficient to remove its authorisation, but do we really want to go down the route of triggering the special resolution regime if a firm happens to change its head office?
The explanatory notes to condition 2.2 talk about how a firms head office might be defined. It is not defined in the Act apparently, nor in the post-BCCI directive, nor in the insurance mediation directive. The FSA handbook states:
This is not necessarily the firms place of incorporation or the place where its business is wholly or mainly carried on. Although the FSA will judge each application on a case-by-case basis, the key issue in identifying the head office of a firm is the location of its central management and control, that is, the location of: the directors and other senior management, who make decisions relating to the firms central direction, and the material management decisions of the firm on a day-to-day basis.
I am not clear whether a breach of that threshold condition is sufficiently important for the stabilisation powers to be used. If it is important we need some guidance in the code to say why. Where the Government are coming from in the threshold conditions is not really about the location of the head office or the appointment of a claims representativeit is about the adequacy of resources. That, to my mind, is the sense of where the Government got to on Kaupthing and Heritable, but all that we know in the context of those two institutions is that the FSA judged that the threshold conditions had not been met. I do not know why the FSA made that judgment and the reason was not apparent from the Treasurys press release on the topic.
If we are talking about adequate resources we should say so in the Bill and the code. We should give people some guidance in the code as to what it means if adequate resources rules have not been met because I think they are subjective terms. I shall give an example from the FSAs online handbook:
FSA will interpret the term adequate as meaning sufficient in terms of quantity, quality and availability, and resources as including all financial resources, non-financial resources and means of managing its resources; for example, capital, provisions against liabilities, holdings of or access to cash and other liquid assets, human resources and effective means by which to manage risks.
That is a very subjective definition of the meaning of adequate resources. We do not necessarily want the FSA to be tied to a quantitative definition but we require some guidance in the code as to what the FSA would deem inadequate resources, to give a flavour of the sort of areas we are looking at. The code is currently deficient in not providing that detailed guidance, which is why I propose amendment No. 81.
On amendment No. 80, the current situation under subsection (4) is that the authorities must have regard to the code. I think the term have regard to is too weak. The authorities might read it, not be very interested, throw it away and not be bound by it, but it is a key part of the structure of this series of reforms and the code is seen by the outside world as an integral part of the package. Simply to have regard to the code is not strong enough to give the right degree of emphasis when bearing in mind the powers set out in part 1. That is why I have suggested in my amendment that the requirement should be on the tripartite authorities to comply with the code or publish an explanation of why they were unable to do so,
in good time after their actions.
Comply or explain is a term that is used quite often by businesses in their accounts. If something does not comply with the code, they explain why. I am suggesting that the same principle should be used in the provisions.
Some other omissions might be dealt with on a stand part basis. Paragraphs 2 to 13 of the code, which set out how the objectives in clause 4 are to be defined, do not go far enough in detail, although we have dealt with that point in the previous debate. Paragraph 29, on page 7 of the code, uses curious language that leads me to thinkalthough I do not think this is the right interpretationthat the default tool for the Bank to exercise is the bank insolvency procedure. Paragraph 29 says:
Under section 8 of the Act, the Bank may only exercise a resolution tool other than the bank insolvency procedure if satisfied that the exercise of the power is necessary.
It is almost as if the Bank of England will start on the basis that it will exercise the bank insolvency procedure unless it thinks the powers in paragraph 8 that enable it to have a private sector purchaser or bridge bank are better. I assume that the default is private sector purchase, that the bridge bank is the second preferred option, and that temporary public ownership or the bank insolvency procedure rank further down the list of priorities.

Mark Todd: The hon. Gentleman highlights a concern that I share. The code is silent on whether the institutions involved should just stand aside and let the bank collapse, on the basis that its collapse poses no systemic risk to financial stability in the UK. That implication is not set out in the code; in fact, the default position is that the authorities will take some action, almost no matter which financial institution is involved, on whatever scale and however isolated the impact might be. I would welcome the greater clarity in the simple position: This is a matter for the market to resolve. We shouldnt be involved at all.

Mark Hoban: I think I understand where the hon. Gentleman is coming fromit relates to the clarity of the code and what the code says the default options should be. As I understand his view, it is that the instinctive reaction is that action should be taken, rather than that the market should run its course and the bank should end up in administration or insolvency. The drafting of paragraph 29 certainly suggests that the expectation is that default will end up in administration or insolvency, rather than that all the stabilisation powers should be used first. Perhaps the language needs to be clarified further to get it right so that we can understand the sequencing or the priorities.

Mark Todd: Will the Committee permit me to clarify a little further? It is important to emphasise the moral hazard position, which is that the public sector should not be expected to step in whenever an institution appears to be threatened. The last few months have almost given the impression that whatever institution is threatened and whichever group of savers might find their savings in jeopardy, the public purse will step in to resolve the matter. The code is an opportunity to make it absolutely clear that that is not the case. There are circumstances in which an institution may be permitted to collapse because it does not pose a systemic risk to the financial stability of the UK, but the last few months have allowed us to drift away from that debate.

Mark Hoban: The hon. Gentleman makes an important point. I am not entirely clear in my mind whether that issue has been properly addressed throughout the crisis. The hon. Gentleman makes the point that before the crisis started, the assumption would be that the market would work its way through some of these issues, that the deposit protection scheme and the Financial Services Compensation Scheme were there to protect consumers and that if a bank collapsed, that would be the route. That goes back to the moral hazard point of viewthe warning to investors, creditors and depositors: Dont expect to be bailed out. You need to think about your own position.
During this crisis, we have moved to a situation where it is expected that our Government and Government generallythe crisis affects countries outside the UK as wellwill leap to the rescue; and to use the Ministers phrase from the evidence session, that we will do whatever it takes to solve the problem. One of the Treasurys challenges in writing the code is to write it in a way that covers both our present situation and what happens when financial stability returns. That goes back to the comment made during the last debate about the context in which such decisions are made. In a time of financial instability, a different set of decisions might be made from those that would be made in a period of financial stability, when moral hazard may well come back to the fore. However, it is important for the code to distinguish clearly between the two situations, and what the impact will be. It is difficult to draft the bit about what the impact would be, because that itself could lead to a degree of uncertainty, but it would be helpful to be able to tease apart the two different contexts.

Colin Breed: I entirely agree with the hon. Member for South Derbyshire. We have, to an extent, drifted away from what was the norm only a few months ago. Of course, there is no obligation on the Government to use the powers; they may not consider the time appropriate to use them. The powers are very clearly designed to protect depositorsthere is no qualification to that. They may be depositors of very significant fundswell in excess of the compensation scheme limitsand if there was a qualification, standing back and letting the bank go might be perfectly acceptable. Some of the objectives have made that position more difficult, which is a slippery slope that I suspect may make Governments wish to return to something more akin to the norm with moral hazard; otherwise, they will be inveigled into trying to come in under special resolutions to protect almost any situation, because of the extent of the deposits.

Mark Hoban: This is a difficult area to get right and I am pleased that I am in the position of having to criticise the code rather than having to draft it. It is a much easier position to be in. The interchange of thoughts about what sort of messages the code sends out is important, because when drafting the code one needs to be very careful about the impression that is created in the minds of depositors, as I alluded to earlier in response to the hon. Member for South Derbyshire before I took the intervention from the hon. Member for South-East Cornwall. For example, if there is a very clear restatement in the code that the limit for deposit protection is £50,000 and that will apply in the future, we may see the shuffling of money around banks, post offices and so on, which may trigger a fresh wave of uncertainty.
We need to get the balance right. It is important, in general, that we try where possible to give as much detail about the context as we can, and to give a degree of predictability even though it may cause some people concern. The more predictability there is in the code, the greater the markets confidence that the code is right and the greater the likelihood that it will know how the powers will be used. That is what the code is abouthow the powers will be used and how market participants can be confident that the powers will not be used will-nilly, at the drop of a hat. We are talking about the controls and the checks on the exercise of the powers, which is why the code needs to be detailed at the front end to give people a greater sense of how the powers will be put into practice.
I am not a great believer in long documents and I always think that it is better to have a shorter ones, but when I opened the file containing the code of practice, I was surprised at how short it was given the complexity of the issues. While this is an early draft, and I suspect that later drafts may elaborate on some of these issues, this area needs elaboration. How should people expect the powers to work into use a different analogywartime and peacetime?
I have some more specific comments. Paragraphs 32 and 33 of the code deal with clause 8 of the Bill:
The test of necessity is a high one. In determining whether the exercise of the power is necessary, the Bank must have regard to whether other approaches would resolve the situation.
Again, I am not sure whether there is enough information in the code to determine when the bank will find it necessary to exercise such powers. The code is a bit light on timings of when things may happen, so we need a bit more specificity in that regard. I draw the Committees attention to paragraph 20, which says that there will be a
revised Memorandum of Understanding between the Authorities
which
will set out how the Authorities will communicate with each other before and during the resolution of an institution.
It is not clear when that memorandum will be produced, and it would be helpful to know. When the Treasury Committee debated the matter, it was suggested that we would see the MOU long after the passing of the Bill. To help us understand how the authorities will interact with one another in the context of the Bill, it would be helpful to have sight of that element of the revised MOU before the Bill completes its passage through both Houses.
In paragraph 33, there is a trade-off. It says:
The assessment must balance the short- and long-term effects on financial stability, public confidence and depositor protection of different resolution options.
That is absolutely right; I could not disagree with that statement, but what does it really mean? What are the short and long-term effects? The paragraph refers to the need to protect depositors but it does not expand to cover the short and long-term effects on financial stability or public confidence.
Paragraph 36 of the code refers to
the operational risks of managing a bridge bank and the amount of public funding that may be required to keep it operational.
There is no sense of where the economic decision comes into play. We talked about the protection of taxpayer interests in the previous clause. The code says that
the Bank will need to take into account in determining the feasibility of different tools
factors such as the operational risks of managing a bridge bank and the amount of public funding that may be required to keep it operational. I do not get a sense of where the balance of judgment is between this and temporary public ownership.
Paragraph 40 of the code does not say much apart from paraphrasing conditions A and B. I think that more work needs to be done on that area if we are to understand how the Bank, or the tripartite authorities, will act in the public interest and how they will apply the conditions. I would have expected more clarity in that area.
Paragraphs 44, 45 and 46 are important and relate to the announcement of the tools and to accountability. I referred to that matter earlier today in the context of amendment No. 80, in which I call on the relevant authorities to comply or explain. Paragraph 46 relates to something that I mentioned in a previous debate. The Minister responded by saying how transparent the Treasury would be over the exercise of such powers. I asked him whether the announcement made by the Treasury in respect of Kaupthing and Heritable was a model or a template for what we would see under paragraphs 44, 45 and 46 or whether we would see a fuller explanation. The Minister did not come back to me on that point, and I was too slow to pick him up on it, but I will give him a second chance in this debate to explainif he has not thrown away the notes that his officials prepared. That is important, because it helps to build up an understanding of how the Government will react in the minds of participants. When people are assessing how the powers will be used, they will look not only at the code, but at how the measures are applied subsequently, to see where the gap is between the application and the code. Therefore, we need to ensure that a decent level of information is available to help participants to understand the range of powers. Also, of course, that is an important part of holding the tripartite authorities to account on how the powers will be used.
I am not a member of the Treasury Committee and I was not able to listen to yesterdays sitting because I was engaged on the Report stage of the Dormant Bank and Building Society Accounts Bill, but I suspect that the Committee would like to debate again Icelandic banks, for example, in the event of the exercise of the stabilisation powers. The more transparency about how the powers will be used and the more announcements that are made about them, the easier it will be for Parliament to hold the authorities to account, which is particularly important when taxpayers money is involved.
Paragraph 52 begins with the words: In exceptional circumstances. What are exceptional circumstances? Are they so exceptional that the Government do not expect the measure to be used? It is important to clarify the definition of exceptional circumstances.
To go back to time periods, paragraph 60 of the draft code states:
However, in situations where there is expected to be a lengthy period of time prior to a sale, the Bank shall put in place an appropriate governance structure.
How long is lengthy, and when does one decide when something has gone from being short to lengthy? If the powers had been available and the Bank had owned the shares in Northern Rock, it might have thought that it could flog it within a couple of months. However, I suspect that the gap between the Northern Rock rescue in September and its nationalisation in February would be deemed a lengthy period if the powers had been available at the time, and it may have been necessary to put in place appropriate governance arrangements. What is lengthy? How long is a reasonable period before steps to put in an appropriate governance structure need to be taken?
In his remarks on a previous clause, the Minister referred to the safeguarding in the code of practice of operating strategies. Paragraph 68 states that that
is likely to involve the bridge bank operating on a conservative basis, to protect the franchise value of the business.
I am not sure what conservative means. Does it mean prudence in the management of liabilities or when dealing with repossessions? Is it conservative in that the bridge bank does not take any risks and operates at the less competitive edge of the threshold? Doing so could impede the achievement of its objectives. Knowing the meaning of conservative in this context would be helpful to the banking system.
I appreciate that no one expects a bridge bank to exist for too long a periodthat is not necessarily its purposebecause there could be other ways in such a period to resolve the situation. Paragraph 72, on the bridge bank report, states:
The Bank must report to the Chancellor about the activities of a bridge bank if a bridge bank exists for a year. The first report must be made as soon as is reasonably practicable after the end of one year beginning with the date of the first transfer to the bridge bank. A similar report must also be made as soon as is reasonably practicable after the end of each subsequent year.
My understanding is that Northern Rock reports quarterly to the Treasury, and I am not sure why the reporting requirements for the bridge bank are less onerous. I thought that they would be broadly comparable.
Paragraph 80, which is on disposal and onward transfer, states:
Following this process, the Bank shall complete the transaction. This may be achieved through a standard commercial agreement...or by exercising the onward transfer powers provided in the Banking Bill.
I do not know whether there is a practical difference between the two options. Will they be used in different circumstances, or are they interchangeable? It is not clear why that might be the case.
Paragraph 93, on page 16, is also ambiguous as to time:
If a bank is likely to remain in public ownership for longer than a short period.
It is sometimes difficult to determine what a short period is. There is no guidance, and the context is the objectives that the Treasury will set for the board of directors. In the case of Northern Rock, even though we are in a period of temporary public ownership, that period has been deemed sufficiently long for the Government to set objectives. The Government could have argued in February that they expected to make a quick sale and therefore would not set objectives. That is a purely hypothetical argument rather than a realistic one, but the presumption should be that objectives will be set for a bank in temporary public ownership.
Having read through the code, I have just picked out some areas where further work needs to be done. I make those points not to sound pedantic or picky but to say that we need to be much clearer about how the code will operate in practice if it is to be the reassurance that the financial services sector is looking for as to how the powers will be exercised.
To touch on amendments Nos. 82 to 85 to clause 6, which I tabled, I wanted to focus on the consultation process surrounding the code. Since I tabled the amendments, the Minister has tabled a new clause that addresses amendment No. 83, which would insert after subsection (1)(c) a new line (d):
those persons whom it considers to have relevant knowledge of those matters..
The new clause, which is not scheduled for debate today, deals with amendment No. 83, because it sets out clearly who should be consulted. In terms of the broader consultation on revisions to the code, the Government might wish to go wider than that. I have also proposed that the code should undergo some form of scrutiny. I would not normally advocate parliamentary scrutiny of a code, but given the importance invested in this one, Parliament should have the opportunity to consider it. It forms an important part of the framework of the Bill.
In conclusion, the code as we saw it on Thursday, which is largely as it will be when it is made available for public consultation later this week, requires a lot more work. One or two people to whom I have spoken who have seen the code share my view that there should be much more detail about how it will work in practice, and others do not yet see it as the safeguard that they anticipated. I hope that the Minister will see my comments as constructive rather than critical for the sake of being critical. We want to be constructive about how we engage on the code, but there is a lot more work to be done.

Colin Breed: The proposal relates to an amendment that we tabled to clause 7. Under clause 5(2)(d) the code will provide guidance on
how to determine whether Condition 2 in section 7 is met.
While I recognise that we are talking about a draft code of practice, what we have so far does not really explain precisely how it will be determined that condition 2 in section 7 is met. It merely repeats some of the wording from the Bill itself.
A fundamental aspect of both the amendments to clause 4 and what is happening in clauses 5, 6 and 7 is how the external investors may view bank shares or banks in the future. Their investment, which can be considerable, may be far less certain than they had originally expected. The determination of whether condition 2 in section 7 is met is fundamental. We need a clear indication of that in the code because that sort of clarity, along with the other aspects of amendments that are yet to come, and one that has already been withdrawn, is fundamental to the way in which the SRR will work.
Timing is obviously of the essence. I accept that and it is recognised in the guidance. But we need to be much more precise about how that condition is exercised. Upon that will depend so much of the perception of whether a bank can raise more capital, whether it has enough investors to begin with and even future capital-raising exercises if necessary. Unless investors are confident that the plug will not be pulled from a bank in which they are going to invest and that the conditions will be clearly met and will not be very subjective in their interpretation, they will be reluctant to invest in such businesses.

Peter Bone: I am trying to follow the hon. Gentlemans argument. Is he making the case that where a bank is in some sort of trouble, but has not reached this stage, investors who might invest in order to save it will stand back if they do not know the precise terms of when the special regime will come in?

Colin Breed: That is exactly right. As the Minister said, the objective is to try to maintain these entities as going concerns. In general terms that will probably require some sort of recapitalisation and additional investment. The conditions under which an entity may ultimately come under some sort of regime may determine whether that capital-raising exercise is successful. We have to make it much clearer that it is not too subjective and that clear conditions have to be met, so that people understand what will happen. As I said, I can see in the drafts no clear explanation of how it will be determined whether condition 2 in section 7 is met.

Mark Todd: I want to amplify briefly the point that I made in my intervention on the hon. Member for Fareham. We are contributing to the process of producing in the code not a specific disaster plan, but a document that is effectively enshrined in law. As it is referred to in the Bill, it will be a permanent feature of the regulation of banking in this country, and will be used as a reference document of some considerable substance.
I felt when I read the code that it was written, perfectly understandably, in the crisis-room mentality of dealing with the circumstances that we face and how we are using powers nowthe hon. Member for Fareham, very fairly, said that it is easier to criticise and a lot harder to write. It was not written in normal circumstances, in which we could perhaps respond with a wider range of policy options than we have been using until now. That is my first, guiding principle.
Additionally, to use a sort of Rumsfeld term, this is an opportunity for us to express certainty about uncertainty, particularly about risk and the principles of risk. One of my anxieties about the way in which the code is written and, of course, to some extent about the necessary actions that we have taken recently, is that they entrench in our citizens, and to some extent our institutions, an assumption that the state will intervene and provide, almost regardless of what circumstances we face. That is, baldly, an unhealthy position.
The document is an opportunityI should say straight away that this needs to be carefully expressedto restate some principles of moral hazard that the states action should in normal circumstances reinforce, although I recognise that these are not normal circumstances. Those principles, broadly, are that if a person runs or invests in a business, they must expect to take risks and, in some circumstances, may find failure and, in ultimate circumstances, utter failure and complete loss of their investment and employment. That is a part of a mixed economy. We should not try to suggest that if a person is in a deposit-taking institution, for example, such failure might not happen because the state can always intervene and resolve some of their problems. That is the first moral message that needs to be reinforced. There are circumstances in which a business might collapse. One can imagine circumstances in which that might be allowed to happen, for example, in the case of a small business or one that operates in such a niche function within the marketplace that its departure might not necessarily cause either a loss of confidence or an impact on financial stability. I think that we have recognised that the US, in the Lehman Brothers example, probably made the wrong judgment about when to reinforce moral hazard and that the consequent effect on confidence and stability was so profound that it should have accepted a greater responsibility to intervene.

Mark Hoban: That is a very good example of when predictability in the market would help. Actually, the expectation of investors, based on actions that the Federal Reserve took on Bear Stearns, was that it would bail out Lehman Brothers. The fact that it did not, and allowed moral hazard to take its course, became an even greater shock, and triggered a further wave of problems.

Mark Todd: That indicates some of the risks in an inconsistency of approach. The world is inconsistent, but the difficulty is that the jeopardy in that case was rather profound. It was probably the wrong decision. I can see why it was made, but I think it was an error. None the less, there might well be circumstances in which some other institution, not quite like Lehman Brothers, could be allowed to fail; and we should allow it to happen.

Peter Bone: I entirely agree with the case that the hon. Gentleman is making, but I have not been able in my own mind to come up with a situation in which any Government, whatever their political colour, would allow a financial institution to go under. Does the hon. Gentleman believe, in reality, that that would happen?

Mark Todd: In reality, the answer is yes. It could happen, and we should reinforce the message that in some circumstances it would. If we do not give that impression in a document of this kind, we risk giving the impression that, in some way, it is a charmed circle activity in which there is some form of interventionbut not, of course, one that necessarily protects shareholders rights; that jeopardy is pretty explicit in the choice of objectives that have been set. However, some other stakeholders certainly have protections in place that provide for the state to be the fall-back position.
The second moral hazard is that depositors should take some responsibility for their decisions when choosing where their deposits should be placed. For perfectly understandable reasonsI do not criticise the Government; I can see where they are and how they got therewe have given the broad impression that whatever has been done by UK licensed deposit-taking bodies, people will be okay to whatever investment limit they have chosen. The difficulty is that if one allows that message to be given out repeatedly, people will chase the best rates without any thought. That, of course, will incentivise market behaviour, which chases exactly those depositors.
It is important, in a document of this kind, to reinforce those principles. It does not need to be done at length, but I would prefer a firm emphasis on ensuring that when the state acts it should, in normal circumstances, seek to reinforce those moral goods in the market place rather than protecting the participants to the point where they lose the inclination for any kind of risk awareness. As the Sage of Twickenham remarked in a debate in which I was able to participate, if we protect everyone from foolish behaviour, we will have a nation of fools. That is a pretty sensible picture of the ultimate outcome of ignoring the moral hazard argument.
I encourage the Government to think further on the approach that they are taking in the code. Much work remains to be done. It has one rather embarrassing typo, which I am sure will be picked up, but there is more work of substance to be done on the document, and I am sure that we can all participate in it.

Peter Viggers: The hon. Member for South Derbyshire made a thoughtful, well-informed and well-judged speech. The lesson of politics is that the battle is not so important; it is the war that matters. I do not necessarily expect the Minister to say that he accepts everything said by the hon. Gentleman and that he will order an immediate redraft, but the points that he made may at some point be taken into account. I completely share his view.
I want to address my remarks to clause 5(2)(d), which is on the crucial issue of the trigger for a special regime. We have to go back to 1997 and the creation of the tripartite arrangements between the Treasury, the Financial Services Authority and the Bank of England. The Bank, to great acclaim, was given the responsibility for setting interest rates, and to effect that the Monetary Policy Committee was created. Rather less noticed was the taking away from the Bank of its responsibility for banking supervision. The FSA was given the duty to control and monitor individual banks, while the Bank of England was given a more general power to control financial stability. The FSA fulfilled its duty, but there is little point in glossing over the facts: there were failures, and they happened on the watch of the FSA, which failed to perceive the systemic risks within some banks. We must learn from our lessons. There is no point in being too polite; we must say that there was a failure there.
The Government propose laying further specific duties on the FSA. Paragraph 26 of the draft code of conduct of the special resolution regime clearly states:
The decision whether the bank or building society fails or is likely to fail to meet the threshold conditions is a regulatory matter for the FSA.
That concerns me, because I have felt for some time that there should be a division of responsibility in the future, based on our learning from our mistakes in the past. The FSA should be given what I regard as the box-ticking, the responsibility for regulation, for ensuring that individual institutions meet certain criteria. The Bank of England, however, should be given responsibility for what I call banking supervision.
I distinguish between banking regulation and banking supervision. It should be possible for not only the FSA but the Bank of England to pull the trigger, because since the FSA is responsible for the routine financial regulation of banks it will naturally be reluctant to come forward and say that normal regulation has failed. It will instinctivelynaturallynot wish to say that the regulation for which it is responsible has not been successful. There should therefore be a separate mechanism giving the Bank of England the power to supervise, and that power of supervision must provide it with enough personnel and abilities for it to be close enough to the management of banks to know when special action is required. Clause 8(1) states:
The Bank of England may exercise a stabilisation power in respect of a bank in accordance with section 10(2) or 11(2) only if satisfied that Condition A is met.
Clause 8(2) then states:
Condition A is that the exercise of the power is necessary, having regard to the public interest in
(a) the stability of the financial systems of the United Kingdom,
(b) the maintenance of public confidence in the stability of the banking systems of the United Kingdom, or
(c) the protection of depositors.
In other words, the Government have put in the Bill the same kind of responsibilities for the Bank as it already has under current legislation. The responsibility for individual bank supervision is to remain with the FSA, whereas the general responsibility for financial stability, under clause 8, will be that of the Bank. That is not good enough.
The draft code of practice envisages, in paragraph 31, that the
three public interest conditions may overlap (to a greater or lesser degree) depending upon the particular circumstances of the bank or building society and the wider circumstances of the financial system as a whole.
So the legislation and the draft regulations envisage that there could be some overlap in the responsibilities and powers of the Treasury, the FSA and the Bank. Good, roll it on. Some level of duplication is necessary. It is not good enough to restrict the regulation and the power to pull the trigger to the FSA; the power to pull the trigger must also be available to the Bank of England, because only the Bank of England has long-term experience of bank control, the levers to affect financial stability and the traditions and ability to discern systemic risk, which the FSA, based on its record, has failed significantly to do.
As happens in the United States, I would give slightly different responsibilities to the FSA and the Bank of England, but I think that it is important that the Bank of England should not be restricted to the exercise of general powers and the stabilisation power referred to in clause 8. It should also have the ability to pull the trigger and implement the provisions to introduce the special regimes.

Ian Pearson: As is evident, clause 5 provides for the Treasury to make a code of practice on the use of the stabilisation powers, the bank insolvency procedure and the bank administration procedure. The authoritiesthat is, the FSA, the Bank of England and the Treasurymust have regard to the code. The clause also provides a non-exhaustive list of the areas on which the code may provide guidance. As hon. Members are aware, a copy of the code was circulated to the Committee last Thursday and, as I said earlier, a consultation document on safeguards, including the code, will be issued on Thursday.
At present, the code covers further explanation of the SRR objectives, how they should be balanced, what regard the authorities should have to the code, further explanation of the roles of the authorities in the SRR, further explanation of how the authorities will judge that the general and specific conditions are met, factors to be considered when choosing the SRR tools, procedure for the announcement of the SRR tools and the Governments arrangements for bridge banks and banks in temporary public ownership. That is not a comprehensive list, and it will undoubtedly be expanded and clarified as a result of the consultation exercise.
We have already had significant debate about the further explanation of the SRR objectives and how they should be balanced, but the hon. Member for Fareham, in a sort of online stream of consciousness, went through the code in fine detail. I will respond to some of his questions. He asked again whether the Kaupthing Edge announcement was a template. Not necessarily; we will consider such matters on a case-by-case basis.
A related question was how long to wait for a statement. We wish to make a statement as soon as is reasonably practicable, but as the hon. Gentleman said, the type of information given may depend, rightly, on the circumstances. For instance, if there is still a risk of loss of confidence in the banking system, that might affect the timing of an announcement as well as what can be disclosed in it. There are tensions between full and immediate disclosure and effective action. I think that he understands that. It explains why, although we want to publish information as quickly as is reasonably practicable, other considerations must be borne in mind.

Mark Hoban: I am grateful to the Minister for that explanationhe picked up that I understand the subtletiesbut the announcement about Kaupthing erred on the scanty side in terms of information. For example, it did not say what trigger conditions Kaupthing had breached to lead to the FSAs withdrawal of permission. That is the level of detail that we want. We do not need to know down to the nearest 5p why there was an issue, but there was nothing to indicate why it had lost that permission. It was missing information that could have been given in any context. Maybe they had lost their claims representative. I do not know.

Ian Pearson: I note the hon. Gentlemans comments and will take them into account as part of our consultation on the code. Regarding the point he makes about the claims inspector, the FSA handbook does refer to all the threshold conditions. The FSA will update its handbook in the light of the Bill and will address such points. On the specific example of the appointment of a claims representative, I can confirm that this condition applies only to regulated activity when it comes to carrying out insurance business.
The hon. Gentleman also referred to paragraph 29 of the code and implied that the bank insolvency procedure is the default option. That is not the intention of this part of the code. This paragraph highlights the need that a strong public interest test, as outlined in clause 8, be met before the Bank of England exercises stabilisation powers which, as hon. Members have noted, are invasive. That is why we always need to think carefully before exercising these powers.
I want to respond directly to comments raised by my hon. Friend the Member for South Derbyshire. I can confirm that it is the Governments intention not to create a zero-failure regime. Indeed, the bank insolvency procedure has been created expressly so that there is a credible failure option. It is possible that the authorities could decide in the event of a bank or building society failure that there is not a systemic risk, that the requirement for action under the special resolution regime is not necessary. I would, however, point out that if a significant number of retail depositors were affected we might still want to use the bank insolvency procedure to ensure effective, fast payout under objective 3, or because perhaps public funds had already been committed previously to the institution which relates to objective 4.
I also want to respond to the point my hon. Friend made that the code was written in times of crisis and that it should it reflect the actions in periods of financial stability as well as instability. The point I made that there is a credible failure option in terms of the bank insolvency procedure is an important one. I would want to reflect on my hon. Friends point while at the same time wanting to be clear that the code is specifically about the actions within the special resolution regime, that is actions that are being taken not under normal conditions but when a bank is failing. Even then, other tests have to be satisfied. In terms of when the code is written, I think it right that we should respond to circumstances as we see them at the moment, but the Bill allows us to revise the code so it can be updated in calmer times as well as in times of financial instability.

Mark Todd: My hon. Friend will be aware that revising a code to transfer risk back to the public and to commercial organisations will be a lot harder than setting out some of those risks at the start of the process, albeit shrouded carefully in this document.

Ian Pearson: I certainly take the points made by my hon. Friend and, as I have said, we will want to reflect on them. I did want to put back to him the point that the code is deliberately designed to refer to times that are not normal because it relates to the operation of the special resolution regime.

Peter Bone: What happens if the independent Bank of England and the FSA think that the failure of an organisation is a one-offnot systematicbut the Treasury and the Government take a wholly different view?

Ian Pearson: I do not think that it is particularly useful to engage in speculation, but, from my experience and from hearing about recent discussions, there are extensive talks between the three organisations that make up the tripartite authorities in which different options and courses of action are debated. It is not possible to set out general principles in this area. We have to look at how things operate on a case-by-case basis.
The hon. Member for Fareham also asked why a bridge bank should report every year when Northern Rock reports quarterly. He may be misunderstanding what we are trying to achieve through paragraph 72 of the code, which is intended to refer to a report on why the bridge bank exists for more then a year, rather than financial reporting arrangements. We would certainly expect the Bank of England to put in place appropriate arrangements for a bridge banks management to report to the Bank in its role as a shareholder.
The hon. Gentleman also asked what conservative management is, and I am very tempted to tell him. We are trying to get the point across that we want to take action that will preserve the franchise value of the banking business transferred to the bridge bank, but we do not anticipate the bridge bank competing aggressively for new business, which was one of the concerns that he tabled an amendment on. The code will be subject to public consultation, and I think that all the points raised by Committee members will be taken into account as part of that process.
Amendment No. 81 is designed to ensure that the code includes provisions on determining whether the threshold conditions, set out in the Financial Services and Markets Act 2000, are met. I do not agree with the intention behind the amendment. The threshold conditions are regulatory conditions under the 2000 Act, and therefore provisions about determining whether they are met are included in the FSA handbook, so it is unnecessary to include in the code any provision on that determination. However, as hon. Members will see, the draft code that has been circulated refers to the FSA handbook, so stakeholders can easily find this detail should they wish. The people involved in these areas are well aware of the situation. I therefore believe that amendment No. 81 is unnecessary.
Amendment No. 80 comments on the manner in which the authorities should treat the code of practice. Clause 5(4) requires the authorities to have regard to the code. The hon. Member for Farehams amendment however, seeks to require authorities to comply or to explain publicly why they did not comply with the code as soon as possible after any action. I shall set out why I do not agree with that approach.
The provisions of the code are intended to provide guidance. For example, the code may set out provisions that should be taken into account or may provide for the approach that the authorities should normally seek to adopt. The expectation is that the authorities should follow the code, and that if they do not, a public explanation would normally be needed. However, a hard-edged statutory requirement to comply with the code would be inappropriate to its function and would unduly restrict the flexibility of the authorities. There may be a number of reasons why a public explanation is not appropriate; for example, if explaining an action that did not comply exactly with the code meant divulging information that itself would put at risk the SRR objectives of confidence in the banking system or financial stability. I consider that to be the appropriate status for the code, in that it will provide a significant amount of detail about how the authorities will implement the SRR and it can be updated to reflect experience gained from operating the SRR without imposing hard-edged duties or requirements on the authorities. I therefore invite hon. Members not to support the amendment if it is pressed.
Before turning to the next set of amendments, which refer to clause 6 rather than clause 5, I shall speak briefly to Government amendment No. 89, whose purpose is to remove duplication under the Bill, by removing subsection (2)(f). Clause 11(3)(c) already requires the information provided for in that subsection to be included in the code of practice, so it is superfluous to make reference to it. The amendment is simply a technical correction and I commend it to the Committee.
The next set of amendments refers to clause 6, which sets out the procedure for developing and updating the code of practice. It requires the Treasury to consult the FSA, the Bank of England and the FSCS before issuing the code. Further, it requires the Treasury to lay a copy of the code before Parliament as soon as is reasonably practicable after issuing the code. As the code is required to be a flexible document that can respond to the authorities experience in operating the SRR and general market conditions, the Treasury can revise and reissue the code.
Amendments Nos. 82 to 85 would introduce extra procedural requirements before the Treasury could agree and issue the code. First, amendments Nos. 82, 83, and 85 would require the Treasury, in addition to consulting the Bank, the FSA and the FSCS, to consult other interested stakeholders. Secondly, amendment No. 84 would require that the code be approved through a resolution by both Houses of Parliament before coming into force. I do not believe that those additions to the procedure are necessary, and I shall explain why.
A number of parts of the Bill, including the powers and areas that affect stakeholders the most, have been and will be subject to full consultationindeed, that is something that stakeholders have welcomedyet none of that is set out in the Bill and nor should it be, as it is already covered by the relevant Cabinet Office and better regulation guidelines on the development of secondary legislation. I recognise that there is, of course, substantial interest in the code. That is why, as I explained earlier, I sent a draft to the new banking expert liaison group last week for discussion at its meeting on Friday, as well as providing a draft to the Committee. As I said, the code will be extensively consulted on when the consultation document is issued on Thursday. Throughout the process of producing the Bill and its supporting documents, we have had full engagement with stakeholders, and we fully intend to continue to follow Cabinet Office guidelines in producing, and consulting on, new secondary legislation and other documentation supporting the SRR. That, I can assure the Committee, will also be the case with the code of practice. The amendments are therefore unnecessary.
Amendment No. 84 would ensure that Parliament formally approves the code of practice by resolution. Again, I do not believe that such an amendment is necessary. Under the Bill, the Treasury has a duty to lay the code before Parliament and of course Parliament is at liberty to ask questions or call for debate on the content of the code. However, the code, just like the FSA handbook, is not a statutory instrument, so I see no reason to require it to be formally approved by Parliament, just as the FSA handbook is not formally approved by Parliament. Again, I hope that our actions in producing a draft code of practice for the Committee to consider as part of the debate shows our willingness to involve Parliament and stakeholders in the creation of the document. I hope that the amendment will be withdrawn.
I conclude on the general issue of the accountability of the authorities to Parliament. The Committee will be aware that the Treasury Committeesome of whose distinguished members serve on this Committeehas been active and scrupulous in holding the authorities to account in their exercise of powers under the Banking (Special Provisions) Act 2008, and also their actions to deal with the wider financial crisis. That is exactly how it should be. The Government expect the Select Committee and Parliament to continue exercising that important responsibility.
I believe that our approach, with full consultation on the secondary legislation and the code, and with the secondary legislation coming to Parliament in the normal way, provides sufficient safeguards. I am sure that the Treasury Committee will continue to hold all the authorities to account.
If hon. Members wish to press the amendments to a vote, I suggest that, with the exception of Government amendment No. 89, they should be opposed.
Debate adjourned.[Mr. Blizzard.]

Adjourned accordingly at fourteen minutes to Seven oclock till Thursday 6 November at Nine oclock.